Winners and Losers in the Coffee Price War

by Will Ashworth | May 22, 2012 8:40 am

The coffee wars escalated last week when J.M. Smucker (NYSE:SJM[1]) lowered its prices 6%[2] for Folgers and the rest of its brands sold in grocery stores. Immediately, investors began speculating who else would follow suit.

Just a few days later we got our answer as Kraft (NYSE:KFT[3]) announced it too was lowering prices[4] by 6% for its Maxwell House and Yuban brands and 10% for its Gevalia brand, which Kraft already was selling in Scandinavia to replace sales lost when Starbucks (NASDAQ:SBUX[5]) ended their relationship in 2011. With arabica bean prices dropping by almost 30% in the past year, it’ll create winners and losers. Let’s see who they are.

Starbucks took over the sale and distribution of its packaged coffee on March 1, 2011. Since then, SBUX stock has increased 68% through May 21 compared to 27% for Kraft. Most of Kraft’s gain is due to its split later this year into two companies[6]. Maxwell House, Philadelphia and Kraft’s other slower-growth brands will be part of a North American grocery business under the Kraft moniker, while its higher-growth brands, like Cadbury, will operate as the newly created Mondelez International division, assuming shareholders rubber stamp the move in a vote Wednesday.

Whatever happens, it appears Folger’s move was meant to provoke a reaction from Kraft — and that’s exactly what happened. Folger’s wants to take market share from Maxwell House, and I don’t see how Kraft comes out of this unscathed.

However, over at Starbucks, I can say with much certainty that it won’t be rolling back of prices in either its channel development segment (formerly its consumer products group) or in its own stores. Customers have gotten used to paying current prices. So, it should benefit now from lower wholesale coffee prices, and then it will simply hold the line on future price hikes when wholesale prices rise again.

It’s been over a year since Starbucks took back its consumer business, and sales have been brisk, up 56.4% to $781.9 million in the first six months of its fiscal year through April 1. I can see this business, which currently accounts for approximately 12% of revenue, growing to 20% of overall revenue. I just don’t see the Folgers-Kraft price war affecting Starbucks in the slightest.

Green Mountain Coffee Roasters (NASDAQ:GMCR[7]), on the other hand, seems like it’s in a heap of trouble. In March, Starbucks announced that it was introducing Verismo, its own single-cup coffee machine[8], later this year that will allow users to make espresso drinks in addition to regular brewed coffee. The news tanked Green Mountain’s stock.

Supporters of Green Mountain mistakenly believe Starbucks is late to the party and that Green Mountain holds an insurmountable lead in the single-serve market. While the latter statement might be true, it made no sense whatsoever for the world’s biggest coffee retailer to not have its own single-cup machine.

Starbucks CEO Howard Schultz rightly worked a deal with Green Mountain so that Starbucks could sell its coffee in K-cups for use with GMCR’s Keurig machines because they’re popular and distribution in consumer goods is everything. How else do you account for Starbucks’ 56.4% increase in grocery store revenue?

This was simply a business decision by Starbucks to bide its time until it could eliminate the middleman. With patents ending this fall, Starbucks could opt to sell its own coffee pods for use in Keurig brewers.

In my opinion, lower coffee prices only exacerbate the situation for Green Mountain because the price drops commoditizes its product at a time when its most important customer is ready to go it alone. I don’t see this ending well for the Vermont company.

Lastly, in addition to Folgers and Starbucks, another potential winner from lower coffee prices is Peet’s Coffee & Tea (NASDAQ:PEET[9]), which saw first-quarter profits drop 39% as a result of roasting prices that were 44% higher in first quarter compared to last year. But this time next year, Peet’s will likely report the exact opposite as lower prices in the future lead to higher profits. Much like Starbucks, Peet’s likely will leave prices alone, opting to keep them consistent.

So, in the end it appears Starbucks, Folger’s and Peet’s will benefit from lower prices, while Kraft and Green Mountain suffer. But no matter what happens with prices, I’d stay away from Green Mountain. It’s in deep pain — just ask David Einhorn.

As of this writing, Will Ashworth did not own a position in any of the stocks named here.